the impact of corporate governance and ownership structure on agency cost in listed

International SAMANM Journal of Finance and Accounting

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35

The Impact of Corporate Governance and Ownership

Structure on Agency Cost in Listed Companies of Tehran

Stock Exchange

Yahya Kamyabi1, Hoda Majbouri Yazdi

2, Ali Ashae

3

__________________________________________________________________

Abstract

This study examines the relationship between ownership and corporate governance to decrease

agency costs in listed companies of Tehran Stock Exchange. To perform this study, data from 123

firms during the years of 2010-2012 is used. Multivariate regression index with constant effect is

used to analyze data. In this study, agency cost is dependent variable that is estimated by the ratio

of incomes (sales) to asset index, and independent variables include percentage of managers

ownership, percentage of institutional investors ownership, percentage of other investors

ownership (except managers ownership and institutional investors), number of board members,

and CEO and chairperson of the board duality. The results of the study indicates that, there is a

negative and significant relationship between agency cost with managers ownership, institutional

investors ownership, and size of the board; On the other hand, there are not any significant

relationship agency cost with other investors ownership, number of board members, and CEO and

chairperson of the board duality.

Keywords: Corporate governance, ownership structure, and agency cost

_______________________________________________________________________________

1Department of Accounting, University of Mazandaran, Babolsar, Iran. Email address: [email protected]

2Corresponding author: Non-governmental scientific institute of Hakimian’s private higher education. Email address:

[email protected]

3Non-governmental scientific institute of Hakimian’s private higher education

mailto:[email protected]

mailto:[email protected]


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36

1. Introduction

Starting corporate governance through stock ownership had a significant effect on corporate

control methods. Separation of ownership from management led to a popular organizational

problem, called “agency problem”. Jensen et al. (1976) offered principles of agency theory, and

described companies as an agents and shareholders as an employer. In their analysis, one

shareholder is against managers. One of the main assumptions of agency theory is that employer

and agents have opposite interests. In this situation, managers are induced to gain miscellaneous

and short-term revenues that led to reduce in shareholders’ welfare and benefits value. Agency

relationship includes a kind of contract under which one or more persons (owner/ owners)

assigned other person (agent /manager) to perform an operation, and they delegate adoption of

certain decisions (Jensen, 1986). Due to the conflicts between the parties, agency costs formed

with the formation of agency relationship. Agency problems between managers and shareholders

exist throughout the world, and government intervenes at surprising speed with providing political

documents and corporate governance terms. Corporate governance mechanisms are those which

support shareholders’ interests. Country economic growth will improve well with the help of good

corporate governance. Ker et al (1999) believed that companies faced with agency’s cost problems

when they have weak corporate governance, and despite of increasing in companies values,

managers of these companies indulge in personal pursuits.

The main objective of corporate governance is “transparency and accountability” in capital

market, but if the state doesn’t pay attention to the transparency and accountability or good

governance issue isn’t considered basically, corporate governance regulation won’t work. Methods

of governance in Iran as a growing economy might be different with developed economic systems.

According to Carmelo et al (2002), prior literature about corporate governance shows that most

studies have been conducted in more developed countries, but little has been done in developing

countries such as Iran, because their corporate governance mechanisms are still being developed.

The objective of this paper is to examine effectiveness of corporate governance mechanisms and

ownership structure to decrease or control agency costs in listed companies of Tehran Stock

Exchange during the years of 2010-2012. This study help to identify factors help to decrease

agency problem and has an implications for corporate governance correction process in Iran.


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2. Literature Review

2.1 Background Of Study

Ang et al. (2000) examined the relationship between agency costs and ownership structure in 1708

of small American companies. In their study, agency cost is calculated in two ways: Asset

turnover ratio and operational expenses to the measured sales. They found that agency cost has an

inverse relationship with internal ownership ratio.

Sing and Davidson (2003) investigated the relationship between ownership structure and agency

costs using a sample 1528 listed companies in American Stock Exchange during the years of

1992-1994. They considered assets turnover ratio and operational expenses ratio to the sale for

measuring agency costs. The results of their study indicated that using the assets turnover ratio as

a measurement of agency costs, increase in the managers ownership leads to increasing alignment

between managers/ owners’ interests, and consequently, reduces agency costs. There was no

significant relationship between external major shareholders’ ownership and agency costs.

Truvang (2006) examined the relationship between board composition and ownership structure

with agency costs of Australian companies. In his study, agency costs were measured by assets

turnover ratio and operational expenses to the sale ratio. The results of 500- company sample

evaluation during 2004 indicated that there is a positive and significant relationship between

management ownership and assets turnover ratio. However, there is not any significant

relationship between the numbers of major shareholders (ownership concentration), held shares

percentage by major shareholders and board composition with agency costs.

Florakis (2008) studied the effects of corporate governance mechanism on agency costs. This

study included 897 English companies during the years of 1999-2003. Agency costs were

measured by assets turnover ratio and operational expenses ratio to the sale. The results of this

study indicated that there is a significant relationship between management ownership, managers’

bonus, and ownership concentration with agency costs.

Ferth et al. (2008) investigated the effects of corporate governance on agency costs. Their study

sample included 1647 observations from 549 Chinese companies during the years of 1998-2000.

Agency costs were calculated by two measures: Assets turnover ratio and operational expenses

ratio to the sale. The results of their study indicated that existence of external shareholders in the

structure of Chinese companies’ owners cause rising in agency costs. However, concentration in


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ownership structure leads to decrease in agency costs. Also, results indicated that institutional

ownership and state ownership have no significant effect on agency costs.

Mac night and Weir (2009) scrutinized the effects of corporate governance on agency costs. Their

study sample included 534 observations of 128 large English companies during the years of 1996-

2000. Regression analyses and Panel data approach are used in their study. Also, assets turnover

ratio and interactions between growth opportunities and free cash flows, and the numbers of

companies acquired by the company were considered as measurement for agency costs. The

results of their study suggested that increase in manager ownership leads to decrease in agency

costs. By using the interactions between growth opportunities and free cash flows as an index of

agency costs, institutional ownership causes decrease in agency costs. Also, there is a negative and

significant relationship between liabilities ratio and agency ratio by calculating agency costs as

assets turnover ratio.

Mashayekh and Esmaeili (2006) explored the relationship between interest quality and some

aspects of corporate governance including percentage of board members ownership and the

number of non-duty managers in Tehran Stock Exchange. The results of the study indicated a

nonlinear relationship between accruals and the percentage of board members ownership.

Hasas Yeganeh et al (2008) tested the relationship between institutional investors and firm value.

Their study sample included 61 companies during the years of 1999-2004. Generally, the results

of their study indicated a positive relationship between the percentage of institutional ownership

and firm value, and confirmed the efficient monitoring hypothesis. However, there is not a

significant relationship between institutional ownership concentration and firm value.

Valipoor and Khorram (2012) examined relationship between corporate governance mechanisms

and agency costs of 51 listed companies of Tehran Stock Exchange during the years of 2001-2008,

and used Panel analysis method for hypotheses test, and the results indicated that there is a

negative and significant relationship between percentage of institutional ownership, manager

ownership, board non-duty members, liabilities ratio to total debt and agency costs at 95%

confidence level.


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3. Theoretical Framework

3.1 Agency Costs

In this study, performance ratio is used to calculate agency cost: Performance ratio represents the

performance index of firm’s managers that is extracted from firms’ financial statements, and it

was used for the first time by Ang Kel and Lin to evaluate the measurement of agency’s costs.

Assets turnover ratio to annual income or sales measures productivity condition and using firm

assets by managers to create more sales. These two ratios as an inverse index are used for agency’s

costs.

3.2 Percentage Of Manager Ownership

Agency costs will decrease with managers’ ownership increase; because, increase in managers’

ownership in a company leads to interest convergence among managers and shareholders’ profits.

Sing and Davidson (2003) advocated the above prediction of agency theory. Anyway, he found the

evidence that agency problem decrease with managers’ ownership increase in a company.

3.3 Percentage Of Institutional Investors’ Ownership

Institutional investor ownership, according to Daren Henry (2006), it is determined through total

shares percentage of institutional shareholders. According to the existing literature of banks,

insurance companies, pension funds, investment companies, etc. are parts of institutional

investors. Institutional investors penetrate using voting right on decision makings and board

structure, so it can be one the monitoring resource on firm management performance. According

to Briky e, institutional investors are more likely to oppose to the managers’ proposal plans that

seems it harms to the owners’ interests. Based on effective monitoring hypothesis, Pond suggested

that institutional investors have high resources and proficiency and can control the management

compared to other private and more unconscious investors with the costs of below-average. And

also, Mac Kenen and Servas observed a positive relationship between company’s performance and

institutional ownership levels and major outer owners.


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3.4 Percentage Of Other Shareholders’ Ownership

Another final variable of this study is percentage of other shareholders’ ownership that is

estimated as the sum of all shares except investors and managers’ shares. Like institutional

shareholders, other shareholders can increase point value with monitoring on company’s

performance that leads to maximize agency’s costs. According to Henry (2006), there is a negative

impact on dependent variable of asset utilization ratio, but it is insignificant apparently. Sing and

Davidson (2003) found similar results in a study of American companies and concluded that

external stock ownership doesn’t have significant effect on agency’s costs when it is measured in

terms of discretionary costs ratio and asset utilization ratio. Maybe, the reasoning for insignificant

relationship between descriptive variable of other ownership and indices of agency’s costs is that

these agency’s variables don’t completely achieve performance measurement systems evaluated

by external shareholders when evaluating the company’s performance.

3.5 The Number Of The Board Members

Small board compared with large board has less power and influence. Sing and Davidson (2003)

also confirmed this result that suggested that there is a statistical positive and significant

relationship between size of the board and assets utilization ratio. They concluded that agency’s

costs will decrease with asset utilization increase. Against, Florakis and Ozkan (2004) in a study

about a sample of British public companies listed on Stock Exchange during the years of 1999-

2003 indicated that size of the board has negative effect on assets turnover of agency’s costs

index, which means larger board size will create more agency’s costs because of less

effectiveness.

3.6 Duality Of CEO And Chairperson Of The Board

Literature indicated that separating the title of CEO and chairperson of the board will improve

company’s performance and helps to decrease agency’s costs. According to Fama and Jensen

(1983), agency theory shows that we cannot separate leadership structure to decrease agency’s

costs. Hence, our hypotheses based on the above discussion are as follows:

H 1: There is a negative and significant relationship between the percentage of manager ownership

and income ratio (sale) to firm assets.


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H 2: There is a negative and significant relationship between institutional ownership percentage

and income ratio (sale) to firm assets

H3: There is a negative and significant relationship between the percentage of other shareholders’

ownership and income ratio (sale) to firm assets.

H4: There is a negative and significant relationship between the board size and income ratio (sale)

to firm assets.

H5: There is a negative and significant relationship between CEO duality and chairperson of the

board with income ratio (sale) to firm assets.

H6: There is a negative and significant relationship between the percentages of non-duty managers

to all board members of a firm with income ratio (sale) to firm assets.

4. Materials and Methods

We selected a sample of 123 listed firms of Tehran Stock Exchange during three years of 2010

until 2012. Data used in this study are extracted from audited financial statements and reports of

firms’ board listed in Tehran Stock Exchange. For this purpose, information is extracted from the

website of research management center and Islamic studies of Tehran Stock Exchange

(www.rdis.com).

Multivariate Regression is used with fixed effects to evaluate the relationship between

governance, ownership structure and agency’s costs index.

Agency cost i,t = αo + β1Director Ownership i,t+ β3Institutional ownership i,t+ β3External

ownership i,t +β4 Board size i,t+ β5CEO- chair duality i,t+ β6 Nxratio i,t + εi,t

4.1 Variable Measurements

Agency cost that is a dependent variable will be estimated through income ratio (sale) index to the

asset.

Manager ownership, according to Daren Henry (2006), we estimated it through percentage of total

shares of the company that are available for all of the company managers.

http://www.rdis.com/


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Others ownership (except managers and institutional investors), according to the Daren Henry

(2006), we described it as the total shares of shareholders (except managers and institutional

investors).

Size of the board, according to Miro Nisat (2004), board size is estimated through the number of

board members.

CEO and chairperson of the board duality, according to Mac Night Rovir (2004), doubling is

included as a dummy variable that its value is equal to 1 if CEO was the chairperson of the board;

otherwise it’s equal to zero.

Non-duty managers’ ratio to all members of the firm’s board is part-time member of the board that

did not have executive job and did not receive annually or monthly fixed salary. Information about

the total number of board’s all members and the number of non-duty members is gotten through

announcements about the decisions of the firms’ common, general assembly and other received

information from Stock Exchange.

5. Results

5.1 Descriptive Statistics

Descriptive statistics is used to analyze collected data, since considered information and data are

both quantitative. Different indices such as central indices and distribution indices are provided in

descriptive statistics that these indices make less and sensible the analysis of hidden information in

data and present an overview about study sample characteristic.

Maximum Minimum

Mean Number Std

Deviation

Year

6.810 0.034 0.826 123 0.672 1388

4.990 0.032 0.839 123 0.580 1389

69.208 0.002 1.607 123 6.468 1390

Table-1 Descriptive Statistics Of Dependent Variable

Table 2 presents a descriptive statistics related to independent variables and dependent variable

during three since 2010 until 2012. As you can see, the mean of agency costs is 1.09 and its

standard deviation is equal to 3.78, and for independent variables of institutional ownership, the

mean and standard deviation are 77.35 and 14.45, respectively. Managers’ ownership with mean


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and standard deviation are 67.73 and 23.09, respectively. The mean and standard deviation for

others ownership are 21.23 and 14.36, respectively and the mean and standard deviation for size of

the board are 5.04 and 0.48, respectively. The mean and standard deviation for CEO and

chairperson of the board are 0.99 and 0.1, respectively. The mean and standard deviation for Non-

duty managers’ ratio are 66.55 and 18.11, respectively. Control variables of firm’s size have the

mean and standard deviation being 5.82 and 0.57, respectively. Firm’s financial leverage has the

mean and standard deviation being 1.08 and 7.77, respectively.

Peakedness

Skewness

Minimum Maximum Std

Deviation

Mean Variable

0.71 -1.13 100.00 0.00 23.09 67.73 DOWN

1.39 -1.13 100.00 20.00 14.45 77.35 IOWN

2.36 1.25 91.65 0.00 14.36 21.23 EOWN

17.12 2.99 8.00 3.00 0.48 5.04 Bsize

88.47 -9.49 1.00 0.00 0.10 0.99 CEO

-0.15 -0.40 100.00 14.00 18.11 66.55 Nratio

362.97 18.99 149.33 0.00 7.77 1.08 Lev

2.05 0.77 7.99 3.98 0.57 5.82 Size

290.59 16.38 69.21 0.00 3.78 1.09 ACost

Table-2 Descriptive Statistics Of Other Variables

5.2 Complementary Model Is As Follows

ACostit = α0 + α1Downit + α2Iownit + α3Eownit + α4Bsizeit + α5CEOit + α6Nratioit + α7levit +

α8sizeit + ɛit

Regression Statistics 0.297 correlation coefficient

0.088 coefficient of determination

0.067 Adjusted coefficient of determination

4.086 F-value

0.000 Probability

Table 3: Regression Table


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Estimate Std Deviation T_value P_value

(Constant) 0.838 0.625 1.342 0.180

DOWN 0.002- 0.001 2.273- 0.023

IOWN 0.001- 0.0004 2.061- 0.040

EOWN 0.913 0.110 0.004 0.000

Bsize -0.182 0.058 -3.166 0.002

CEO -0.215 0.247 -0.870 0.385

Nratio -0.001 0.001 -0.346 0.729

Lev -0.008 0.003 -2.322 0.021

Size 0.128 0.047 2.701 0.007

Table 4 :Parameter Estimation

A logarithmic conversion for “Acost” variable is used, due to un-establishment of the fundamental

assumptions (normality and variance constancy and correlation of residuals). (ln(Acostit)+1) and

also irrelevant values were omitted based on an initial regression.

5.3 Evaluation Of Model’s Congruence

Colmogrov-Smirinov test confirms comparative normality of residuals (K-S=1.018, P= 0.251) and

the graph of being variance constancy is confirmed and Camera-Watson statistics (D-V=1.756)

indicates residual’s lack of correlation, too.


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The graph of estimation versus residuals for evaluating variances constancy

6. Conclusion and Discussions

Agency costs are arisen by conflict of interests between managers and owners and it has an inverse

effect on the firm value. Corporate governance is one of the mechanisms to control agency costs.

We evaluate some of these mechanisms’ effect on agency costs in listed companies of Tehran

Stock Exchange by using mechanisms of corporate governance and ownership structure. The

results of this study indicated that corporate governance mechanisms are adequate to decrease

agency costs and therefore, firm value increase. Finding suggested that there is a negative and

significant relationship between managers’ shares ownership with agency costs. In other words,

increase in the percentage of managers’ shares ownership will decrease agency costs; it means that

with increasing managers’ shares ownership, interests of the managers and shareholders will be

more consistent together. Therefore, findings of the study are consistent with the results of

researchers’ study such as, Sing and Davidson (2003), Fleming et al (2005), Trovang (2006),

Florakis (2008), Mac Night and Veir (2009). And also, there is a negative and significant

relationship between the percentage of institutional investors’ ownership with agency costs that

represents effective and active influence of institutional investors on company managers’ decision

making and decreasing the conflict of benefits between managers and owners. Therefore, increase

in percentage of institutional ownership will decrease agency’s costs. These are consistent with the


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findings of the studied conducted by Woo (2004), Nouravesh et al (1388), Nouravesh and

Ebrahimi Kordlor (1384), Hasas Yeganeh et al (1387), Hashem Valipoor and Ali khorram (1390).

And also, there is a negative and significant relationship between firm size and agency costs which

means that larger board size will increase agency costs because of less efficiency. Of course,

researchers have found twofold results in this case: Sing and Davidson claimed that small board

compared with the larger board has less effects and power, i.e. existence of positive and significant

relationship. Contrary, Florakis and Ozkan (2004) indicated that larger board size will increase

agency’s costs because of less efficiency.

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